Political Games And Currency Fuss

ByDavid R. FrancisSeptember 25, 1992

EDWARD BERNSTEIN, a famed expert in international monetary affairs, doesn't mince his words on President Bush's suggestion to European central bankers and finance ministers last Sunday that a basket of commodities, including gold, be used as one of several indicators for setting relative currency values.

"It is real nonsense," says Dr. Bernstein, now with the Brookings Institution in Washington.

Stanley Fischer, a former chief economist for the World Bank, was no less critical. "That is just a decoy or diversion," says the Massachusetts Institute of Technology economist. "I don't know what it has to do with anything."

In Washington, the suspicion is that the proposal has more to do with Republican politics than reality. As Mr. Bush moves toward the center at election time, throwing a bone to the right wing of the party can be politically useful. Certainly the proposal pleased the supply-side writers on the editorial page of the Wall Street Journal. A gold and commodities standard for currency is also advocated by Lawrence Kudlow, chief economist at the Office of Management and Budget during some of the Reagan years an d now chief economist with Bear Stearns &amp; Co., a brokerage house.

"The G-7 [Group of Seven major industrial democracies] must quickly meet to adopt a true growth strategy, including a coordinated commodity price rule, which will lead to sharply lower interest rates," writes Mr. Kudlow.

President Bush was cautious in his suggestion, saying that in order to strengthen the coordination of economic policies between the G-7, the US will advocate that "we explore the development of an independent reference point" - the commodity basket.

But Bernstein, a member of the US delegation at the 1944 Bretton Woods conference that established the postwar international monetary system, says a commodity-based standard has been proposed at least 12 times since then and gone nowhere. Commodity prices, he says, are too volatile to be suitable as a reference point. The goal of monetary policy should be stable prices for domestically produced finished goods, he says.

Fischer says there is "no good reason" why a commodity standard is better than a central bank pursuing a price level target through its monetary policy. But considering the turmoil on the foreign-exchange markets, Bush "had to say something" to the visiting European officials, Fischer says.

This week, the French franc has been under pressure in the foreign-exchange markets to devalue. But it is being defended by both the German Bundesbank and the Bank of France.

The realignment of currency values resulting from the crisis should be good for the European economy, Fischer and Bernstein agree. Britain, France, and Italy were in recession or heading toward it. Britain's government didn't devalue against the German mark earlier because it didn't want to admit a mistake in setting the exchange rate of the pound when it joined the European Rate Mechanism in 1990, Bernstein says. Some other members of the ERM that resisted devaluations (including France) despite high un employment rates, he adds, were "showing off" - too proud of their progress on price stability.

This week Britain lowered its interest rates. Other countries will do so soon. "After an interval to show that it is not acting under duress, the Bundesank will probably lower its interest rates," predicts Bernstein.

An economic recovery in Europe should boost United States exports. Lower interest rates in Europe also will make it easier for the Federal Reserve to trim US interest rates further.

Bernstein figures that the goal of establishing a single European currency has been set back to the distant future. The common central bank and currency that were planned for 1999 would in effect alter Europe's constitution. So the 51 percent approval by French voters of the Maastricht Treaty on European unity is not sufficient for such a far-reaching change, he says.

Nonetheless, the ERM is expected to continue for much of Europe because of its advantages. It reduces the volatility (day-by-day fluctuations) in foreign-exchange rates of its member currencies, notes Bernstein. It does not prevent periodic rate adjustments - as the current realignment shows.